First Publicly-Traded Minerals Yield Vehicle with High Multi-Year Growth Potential
Viper Energy Partners LP (VNOM) was formed (by Diamondback Energy; “FANG”) as a Delaware limited partnership to own and acquire royalty-bearing mineral rights (oil, liquids, natural gas) in the U.S. and maximize unitholder distributions. Its initial assets include 14,804 prime acres in the West Texas Permian Basin that are leased to working interest owners who bear E&P costs. Diamondback operates about 50% of Viper’s gross acreage. Viper receives a 21.4% average royalty interest on all production.
Viper went public on June 18, 2014, with 5 million units priced at $26 per unit, well above the company’s initial filing range of $19 – $21 per unit. Units jumped 24% on the first day of trading to close at $32.35 per unit amid high demand. Viper also offered the standard 15% overallotment option to underwriters on 750,000 additional units which will be filled as units are already deeply in the money. Post IPO, Diamondback will own 92% of outstanding common units (assuming full exercise of overallotment).
At $32.35 per unit (as of 6/18/2014), with 76.2 million units outstanding, the company has a market capitalization of $2.5 billion (30x distributable cash flow). Units closed the week at $33.99 (as of 6/20/2014), well above pro forma book value of about $6 per unit.
Viper plans to initially pay $0.275 in quarterly distributions ($1.10 annually) so units offer a distribution yield of 3.4% which is less than many MLPs but is expected to grow over time.
Through its IPO, Viper raised $130 million in gross proceeds, not counting overallotment. Viper plans to distribute net proceeds (roughly $120 million after offering fees and expenses), including proceeds from overallotment, to parent company Diamondback Energy, Inc. (FANG) which will use the money to reduce outstanding debt under a revolving facility.
Investment Highlights – Innovative First-Mover “Royalty Focused” MLP
Viper Energy was formed by Diamondback Energy (which holds a 92% stake in Viper) as an innovative first-mover MLP focused solely on royalty receivables from mineral rights owned, and plans to distribute substantially all royalties after minimal MLP administration expenses.
Viper owns approximately 14,800 acres in the core of a highly productive part of the Northern Midland Basin (West Texas’ Permian Basin; area known as Spanish Trail). As of March 2014, production was 79% oil (91% oil and NGLs) and natural gas. Viper will collect royalties in perpetuity on sales of oil, NGLs and natural gas pumped out of its lands.
As of March 31, 2014, Viper had 22 horizontal and 210 vertical producing wells on its acreage, and over 12 years of organic drilling inventory. Operators are currently de-risking horizontal well operations before they drill more.
Viper will generate high margins off royalty revenues because it has no maintenance capital or lease operating expenses (LOE).
Geological core samples show multiple pay zones (and greater productive depth) in Viper’s acreage that offers significant vertical and horizontal drilling advantages and multiple years of drilling inventory. Moreover, Diamondback Energy is a leader in horizontal drilling with over 70 such wells in the Midland Basin.
Viper plans to leverage its first-mover advantage – as a mineral yields’ MLP – to propel significant growth organically and through prime acreage acquisitions.
Viper will generate organic growth in royalties through
increased drilling activity from proven and well-capitalized operators. Diamondback’s operated acreage has 257 identified potential vertical drilling locations and 322 identified potential horizontal drilling locations. Acreage operated by RSP Permian (RSPP) has similar potential but has not yet identified potential well locations. Diamondback and RSPP plan to drill 47 horizontal and 36 vertical wells over the 12-month period ending June 30, 2015.
Over the next twelve months, Viper expects to increase production by 46% to 3,176 Boe/d and grow distributable cash flow 40% to $84 million.
Viper will receive additional mineral/royalty interest from production at new wells. In addition, Viper plans to team with Diamondback on acquisitions of third-party mineral and royalty interests.
Viper will also benefit from the significant management expertise that Diamondback brings. Diamondback shares, for example, have returned 350% since their October 2012 IPO primarily due to lower expenses, higher operating margins and high production properties, making it the best performing E&P stock over the past few years. Management could repeat this out-performance with Viper too.
Viper/Diamondback management has proven expertise in identifying and closing accretive acquisitions (with $900 million in acquisitions completed since its Oct. 2012 IPO), and a demonstrated track record of generating superior returns based on rapid production growth and operational execution. Viper’s acreage is integral to Diamondback’s growth and 50% of Diamondback’s rigs now operate in Viper’s acreage.
Viper management has deep industry expertise and is strongly aligned with public unitholders. Viper CEO Travis Stice, also the CEO of Diamondback Energy, has 15 years of solid experience in the Permian Basin and over 26 years at U.S. E&P companies. Ms.
Tracy Dick serves as CFO at both Viper and Diamondback, and has over 20 years of accounting experience in the oil and gas sector. Russell Pantermuehl serves as Vice President – Reservoir Engineering and has over 30 years of deep reservoir evaluation and production expertise.
Viper was formed by Diamondback to directly own mineral interests in the heart of the Midland Basin. Viper has no maintenance capital expenditures and no direct operating costs, so substantially all of its royalties can flow to unitholders. The company does not plan to hedge its royalty stream against oil and gas price volatility.
Viper has not issued incentive distribution rights (IDR) or subordinated units; as a result, public unitholders are at parity with Diamondback on distributions per unit.
Industry-Leading Operating Margins
On a comparable basis, if revenue was $80.93/Boe, Viber’s mineral interest model has operating margins of $72.27/Boe versus $24.70/Boe for working interest owners. As a result, Viber is less at risk from fluctuating commodity prices. Working interest operators are exposed to operating and capital expense overruns and greater execution risks. So Viper’s cash flow generation is a key differentiator from other E&P yield vehicles.
Favorable Acreage Location, “Tombstone to Granite” Stacked Payzones
Viper is positioned in the heart of the most active basin in North America. Viper has proved reserves of 10.270 Mboe of which 72% is oil and only 52% has been developed to-date.
Viper’s acreage is mostly operated by Diamondback and RSP Permian. Production has ramped
up 37% from 1,600 Boe/d in June 2013 to 2,197 Boe/d as of March 2014, with three horizontal and two vertical rigs actively drilling and more rigs planned. In total, Viper has identified 557 potential horizontal locations (322 for Diamondback) and 502 vertical locations (257 for Diamondback).
Viper’s high oil content supports some of the best drilling economics in the region.
Viper’s acreage is central to strong well survey results in the Midland Basin. A map of horizontal drilling permits shows a northerly trend toward Viper’s acreage. One of Diamondback’s wells was among top producers in the area with 2,286 Boe/d with 88% oil.
Petrophysical analysis shows there is significantly more oil in the Midland Basin compared to other major U.S. shale oil plays. Viper owners have access to over 4,000 ft of stacked pay-zones (vs. 500 ft for other plays). And new surveys continue to reveal new recoverable resources in the Midland Basin.
Solid Financial Profile, Liquidity
For the quarter ended March 31, 2014, Viper had royalty income of $15.9 million, up 6%, and derived 92% of its royalty from oil sales, 5% from NGL and 3% from natural gas. The company recorded $12 million in expenses of which $5.6 million was depletion expense and $5.4 million was interest expense (which it will not bear going forward).
Future revenues could vary substantially due to changes in the production/pricing mix.
Viper has zero debt and no interest expense, and plans to enter into a $100 million revolving credit facility for general administration and partnership expenses. Viper may issue debt or additional equity, or selectively retain cash to fund acquisitions. The company expects ad valorem taxes of about 7.5% of royalty income. Operators (Diamondback and RSP Permian) bear capital and E&P expenses, allowing Viper to grow organically without any drilling capital.
$83.8 Million in DCF for 2015
For the 12 months ending June 30, 2015, Viper forecasts production at 915,106 Bbls oil, 643,946 Mcf of natural gas and 136,687 Bbls of NGLs, for a total of 1.16 MMBoe, and expects royalty income of $93.8 million of which it expects to pay $7 million in taxes and $3 million for G&A, leaving distributable cash of $83.8 million for 76.2 million units outstanding ($1.10 per unit).
After the IPO, Viper expects to have about $440 million in assets and $348 million in members’ equity.
Viper Energy Partners is an innovative first mover as a publicly-traded MLP focused purely on mineral rights. This pure-play focus translates into high operating margins and high distribution payout. The company has prime acreage with rich oil yields, and promising organic growth prospects with new drilling planned at identified horizontal and vertical well sites which will boost royalty revenues. Viper will also benefit from its relationship with parent Diamondback, which could drop-down assets or assist Viper with acquisitions. At 30x distributable cash flow, shares appear rich but reflect solid future growth prospects. Viper’s primary focus on oil, given current geopolitical turmoil, should keep oil prices high for the foreseeable future and deliver healthy royalties. A significant dip in oil prices is unlikely for now but a drop back to the $50 – $80 range a few years from now could crimp profits. Viper is a quasi-speculative play with significant potential earnings volatility directly tied to oil prices. Investors should protect downside through smart hedging strategies.